A comprehensive revision of India’s Companies Act has been anticipated for decades. Bhawna Gulati of Reliance Industries evaluates one of the proposals to streamline the law and argues that urgent measures should be taken to improve corporate governance, protect shareholders and make the economy more competitive
The challenge of improving mechanisms for corporate governance has kept researchers in developing economies busy for decades.
With an increasing number of diverse corporations and individuals involved in the economy, an awareness of the need to ensure better corporate governance has spread in developing, emerging and transition economies – economies where the topic was once relegated to the backfields of discussion. Factors such as cheaper financing and portfolio investments by foreign funds have helped the matter regain prominence.
The fact that good corporate governance enhances productivity and sustainable development – while helping reduce the waste of capital resources that paralyzes growth – serves to underscore the importance of the discussion.
India’s Companies Act, 1956, is voluminous. It has 658 sections, 15 schedules and has been amended 24 times. Still, many of its provisions are completely out of touch with the times. It suffers from numerous infirmities, the most obvious being its complexity and clumsiness, which often makes it a very inefficient law.
Over the years, various high-powered committees have examined the act in an attempt to make it more user-friendly. Most prominent among them was the JJ Irani Committee report, published in 2005.
Released with much fanfare, the comments provide a reasonable platform for changes in a piece of legislation that has done much to hamper the development of India’s corporate environment and little to transform the country into an attractive investment destination.
Regrettably, the report has remained untouched on the shelf for three years.
The general thrust of the recommendations – to streamline the law and make it more practical and user-friendly – was welcome. However, other recommendations have the potential to create unnecessary complications. The key suggestions of the report are as follows.
Insolvency
The JJ Irani Committee suggests that a sound framework for the restructuring of companies, along with improved winding-up and liquidation proceedings, is the need of the hour. This would provide a genuine opportunity to explore company reorganization and the rehabilitation of potentially viable businesses with stakeholders, while also hastening the closure of sick companies that have no possibility of revival so that unproductive resources may be redeployed.
The idea of creating an expert independent statutory body to oversee insolvency proceedings is another step in the right direction.
However, the move to put an insolvency law under the umbrella of the Companies Act may end up complicating – rather than streamlining – bankruptcy proceedings that are already incredibly time-consuming.
In fact, any move to limit the role of the judiciary by creating a parallel hierarchy of conflicting jurisdiction is not likely to find favour with the high courts.
Still, the move to make insolvency proceedings timebound is long awaited.
Instead of incorporating the provisions regarding insolvency in the Companies Act, it would be more beneficial if a separate set of bankruptcy laws were enacted.
Independent directors
The Irani committee has opined that a minimum of one-third of the total number of directors being independent directors should be adequate for a company with significant public interest, regardless of whether the chairman is executive or non-executive, independent or not.
This will, undoubtedly, enhance corporate governance by putting truly independent directors who do not represent any sectional interests on the board of companies. A set of expanded liabilities for celebrities sitting on corporate boards and the prescription of basic duties for directors could definitely create an environment of responsibility and accountability.
The fixation of quantitative limits will, however, serve no purpose without predetermined qualitative standards.
The law should recognize the principle of independent directors and spell out their roles, qualifications and liabilities and incorporate the definition of independent director within the act.
Consolidating holding companies
How companies manage their subsidiaries (and the funds these generate) is another issue that comes under the spotlight of the Irani report.
Instead of attaching accounts from subsidiaries alongside those of their holding companies for circulation to shareholders, as is currently required, the committee suggested holding companies provide consolidated statements as well as individual financial statements. The committee also recommended setting a limit for the number of subsidiaries a holding company can have.
The Companies Act, the committee held, should not force a particular structure for business. These prescriptions risk rigidifying the business environment, placing Indian companies at a disadvantage.
Mandatory consolidation of financial statements of holding companies and subsidiaries can improve corporate governance by allowing holding companies and their subsidiaries to mutually offset any losses.
However, the committee emphasized that the holding subsidiary structure is not solely responsible for any siphoning of funds. Companies use other structures for the same purpose and isolated instances of misuse should not result in the elimination of an effective business model altogether.
One-person companies
Another recommendation, aimed at eliminating barriers for small companies, called for individuals to be able to start companies with little or no government interference in the appointment and removal of directors. The committee also suggested that one director of every company should be Indian and that government approval be required for non-resident management appointment.
Introducing the idea of a one-person company into the legal system is a creditable move that would encourage entrepreneurs and businesses to incorporate – as is the case in many other jurisdictions including the UK, Australia, Singapore and Pakistan.
This would offer small entrepreneurs who own a business the limited liability of incorporation without cumbersome compliance requirements.
Class action suits
Another recommendation seeks to empower shareholders to hold companies and management responsible for wrongdoing through class action and derivative suits. Minority shareholders should, according to Dr Irani, be allowed to sue in their own name or on behalf of the company in cases of fraud on minority shareholders.
Derivative actions dealing with non-ratifiable decisions would also be allowed as long as shareholders do not file them in their personal capacity.
The committee also called for the creation of class action or representative suits that could be filed by one shareholder on behalf of a group belonging to the same kind.
Class action is common in developed economies, particularly in the US and Europe.
The recommendations with regard to the protection of small investors are praiseworthy, especially in view of the fact that India is known for its efforts to protect investors. Giving minority shareholders the option to approach the courts to redress their complaints would strengthen their rights regardless of their holdings.
Class action allows shareholders and consumers, especially smaller ones, to band together. These suits also lessen the burden on the courts, as a large number of lawsuits can be clubbed together, allowing a single.
Mergers and acquisitions
In order to ease the process of mergers and acquisitions, the committee suggested a number of provisions in line with global standards, including setting up a single-window clearance mechanism for mergers, removing ceilings on director remuneration and a system of deemed regulatory approvals in case proposals are not cleared within a stipulated period of time.
The merger process in India is court-driven but the committee suggested that contractual mergers be allowed without judicial intervention but with subsequent approval from a majority of shareholders, while dissenting shareholders would need to constitute a minimum percentage to halt the process.
These recommendations could ease the process for companies while protecting the rights of shareholders. Making it incumbent upon opposing shareholders to make up a minimum number could rule out frivolous and mischievous opposition.
Offences and penalties
The Registrar of Companies is a statutory authority entrusted with the administration and enforcement of the Companies Act. The registrar is also responsible for ensuring that boards of directors, entrusted with the management of the company, perform with transparency, integrity and accuracy.
The problem in law is that the registrar cannot take cognizance of petty irregularities and can only issue a show cause notice, with prosecution as the sequel for no or unsatisfactory replies. It is a body with a lot of bark and no bite.
The Irani Committee recommended that the Registrar of Companies be allowed to compound technical and procedural offences to lower the cost of dealing with cases and cut down on the number of prosecutions.
Streamlined legislation
The committee’s suggestion of replacing the current extensive legislation with just 300 sections (less than half the number contained in the current act), including more contemporary recommendations concerning faster incorporation and liquidation of companies, are well conceived. Efforts to reduce the number of sections to create a concise and abridged piece of legislation will, however, be meaningless, until a fluid framework is developed to allow companies to grow.
The law needs to be drafted in a flexible manner to enable amendments as corporate realities continue to change swiftly in India and around the world. As Indian companies are increasingly exposed to the global economy, this becomes crucial.
Apart from making the law simpler, the time has come to do away with the complicated structure of provisos, explanations and multiple cross references.
It is pertinent at this juncture to note that most countries have already overhauled their laws to match the realities of the changing corporate and economic landscape. Today, when India is a preferred investment destination, it is essential to make the basic legal framework accommodating in order to attract more domestic and foreign investment. Multinational enterprises are still testing the Indian waters and therefore, it is essential for India to infuse flexibility and certainty in the legal framework governing companies.
Unfortunately, the obsession with the size and age of the current act has overtaken any serious debate on why the law has failed as a tool for corporate governance and as a bulwark against corporate fraud. These obstacles could become a thing of the past if the Irani committee’s recommendations are heeded.
It is also worth noting that one of the major issues creating anxieties for foreign companies entering India, is the country’s cumbersome winding-up procedure. It is extremely difficult to retrieve money once a company goes into liquidation.
But unfortunately, the Irani committee has little to suggest on this subject.
Another area left untouched is the seemingly unenforceable nature of contractual obligations, a problem that results in complex, long and expensive lawsuits that provide minimal routes to a resolution. Even arbitration proceedings generally end up in the courts. It would be highly desirable for the government to develop legislation to change this situation.
Most importantly, any new law should lay down a broader framework and adopt a liberal approach towards day-to-day regulations to ensure that India’s corporate environment becomes and remains globally competitive and attractive for domestic and foreign investment.
Bhawna Gulati is a consultant on taxation and regulatory services for Reliance Industries.
